On January 1, 2014, Packard signed a 5-year noncancelable lease for a machine. T

Question

On January 1, 2014, Packard signed a 5-year noncancelable lease for a machine. The terms of the lease called for Packard to make annual lease payments of $8,751 at the beginning of each year, starting January 1, 2014. The machine has an estimated useful life of 6 years and a $4,000 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Packard uses the straight-line method of depreciation for all of its plant assets. Packard's incremental borrowing rate is 11%, and the Lessor's implicit rate of 10% is unknown to Packard.

Immediately after making the initial payment, what should be the amount of the capital lease obligation reflected on the books of Packard Corporation?

Explanation / Answer

Solution:

Annual lease payment at beginning of period = $8,751

Period of lease = 5 years

Incremental borrowing rate of packard = 11%

Present value of minimum lease payment = Annual lease payment * Cumulative PV Factor for annuity due at 11% for 5 periods

= $8,751 * 4.102446

= $35,900

Initial payment made = $8,751

Amount of the capital lease obligation reflected on the books of Packard Corporation after making initial lease payment = $35,900 - $8,751 = $27,149

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